Purcell Farms Inc. has the following data, and it follows the residual dividend model. Currently, it finances with 15% debt. Some Purcell family members would like for the dividend payout ratio to be increased. If Purcell increased its debt ratio, which the firm's treasurer thinks is feasible, by how much could the dividend payout ratio be increased, holding other things constant?

Question

Quizplus · Accepted Answer

By increasing the debt ratio, Purcell Farms Inc. would reduce the equity financing needed for its investments, thus freeing up more earnings to be paid out as dividends. This would allow the dividend payout ratio to increase, and the calculation shows it could increase by 38.6%.